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Saturday, November 8, 2014

Note to Prospective Home Buyers ... When Buying, Consider REAL AFFORDABILITY Because You're on Your Own ... Common Sense Rules Apply

An individual home buyers should not buy the most expensive home on which he can make the required monthly payment. The decision instead should be based on what he realistically can afford in terms of the total debt owed. It's a debt thing.

Home builders, realtors and lenders, all aided and abetted by the government, will be cheering the potential buyer on and to focus only on the monthly payment. That will enable them to sell and the purchaser to buy the highest priced home available. When the transaction is completed, the repayment obligation belongs to the buyer and the collection obligation in effect is that of the government, aka taxpayers. The bank passes the loan on to Fannie, Freddie or the FHA, who are the real lenders. In turn, the taxpayers and the individual home buyer are the ones on the hook --- not the friendly realtor, builder or lender.

And those realtors, builders and lenders want the buyer to focus on the monthly payment plan because the higher the sales price, the more money available to split between the various interested 'selling' parties. And our 'ever helpful' government officials through legislation will enable this bad behavior, because politicians always are looking for ways to support those vested interests who lobby and support them with political donations. It's a 'you scratch my back and I'll scratch yours' thing. And that list of back scratching politicians, real estate friends and supporters does not include the individual home buyer. So when buying a house, please be careful.

Home buying is or should be very much a MOM (my own money) thing, and the following three simple rules should guide us: (1) the higher the down payment, the better; (2) the shorter the length of the mortgage loan, the better; and (3) the lower the interest rate on that loan, the better. It's that simple.

And if we adopt the three simple rules approach to home buying, the sooner we will accumulate equity and decrease our debt levels. That will make us happy campers and eligible to become members of the 'non-excessive debt owed home owners club.' And the club needs more members.

Not many years ago, the conventional wisdom was that a person could never go wrong buying the most expensive house possible, and it was always deemed a good time to buy. Buying a home was viewed as a can't miss winning investment.

Leveraging to the max and borrowing to the hilt was the game. Buyers expected to make a small fortune by borrowing as much money as possible and then sitting back and watching home prices increase. Then it was time to "flip" the homes, pay back the loans, make lots of money and move on to the next home. Easy money all the way around.

But then the inevitable happened and the home price bubble burst. I say inevitable because if something can't go on forever, it won't. And prices don't always go higher. So they came crashing down with a thud. But that apparently wasn't the end of the story. Lesson not learned, I guess.

Because now lobbyists from the real estate industry, bank lenders and elected officials, are on the scene and attempting to repeat the "home is a great purchase and can't miss money making investment" debacle. Doubt what I'm saying? Then please read on.

"SEVEN years after the housing bubble burst, federal regulators backed away . . . from the tougher mortgage-underwriting standards that the Dodd-Frank Act of 2010 had directed them to develop. New standards were supposed to raise the quality of the “prime” mortgages that get packaged and sold to investors; instead, they will have the opposite effect.

Responding to the law, federal regulators proposed tough new standards in 2011, but after bipartisan outcries from Congress and fierce lobbying by interested parties, including community activists, the Obama administration and the real estate and banking industries — all eager to increase home sales — the standards have been watered down. . . .

The regulators believe that lower underwriting standards promote homeownership and make mortgages and homes more affordable. The facts, however, show that the opposite is true.

In the late ’80s and early ’90s, down payments were 10 to 20 percent. The homeownership rate was 64 percent — about where it is now — and nearly 90 percent of housing markets were considered affordable (that is, home prices were no more than three times family income). By 2011 only 50 percent were considered affordable, and by 2014, just 36 percent — even though down payments as low as 5 percent are now common.

How could this be? Consider this: If the required down payment for a mortgage is 10 percent, a potential home buyer with $10,000 can purchase a $100,000 home. But if the down payment is dropped to 5 percent, the same buyer can purchase a $200,000 home. The buyer is taking more risk by borrowing more, but can afford to bid more.

In other words, low underwriting standards — especially low down payments — drive housing prices up, making them less affordable for low- and moderate-income buyers, while also inducing would-be homeowners to take more risk.

That’s why homes were more affordable before the 1990s than they are today. Back then, when traditional standards for “prime” mortgages prevailed, homes were smaller . . . .In a competitive housing market not subsidized by lax standards, home builders would similarly adjust by reducing the size and amenities of new homes to meet the financial resources of home buyers entering the market. Home prices would stabilize and not rise faster than incomes. Low- and moderate-income families and millennials might have to wait to save for a first home, but they would be able to afford it.

(Higher down payments are not the only way to limit excessive borrowing. The “standard” 30-year mortgage is a subsidized, archaic result of our government’s distorted housing policies; very few home buyers stay in a home for 30 years. A 15-year fixed-rate mortgage means higher monthly payments, but the homeowner starts to accumulate equity sooner, reducing the lender’s risk.)

If the government got out of the way, would sound underwriting standards come back? History suggests yes. Although Fannie Mae and Freddie Mac were government-backed, they were shareholder-owned, profit-making firms. They adopted strong underwriting standards to avoid the credit risk of subprime and other high-risk mortgages. But after Congress enacted affordable-housing goals, administered by the Department of Housing and Urban Development, in 1992, underwriting standards declined. . . .

It’s clear that today’s policies create winners and losers. The winners include real estate agents and home builders, who want to increase borrowing and sell ever-larger and more expensive homes. The losers, as we saw in the financial crisis, are borrowers of modest means who are lured into financing arrangements they can’t afford. When the result is foreclosure and eviction, one of the central goals of homeownership — building equity — is undone."

Summing Up

Homes are a great place to live. They are not great investments.

Homes should be used to live in, and 401(k) accounts should be used for investing.

Do not take on more debt that you can handle. Do not go out on a limb and risk becoming a loser.

Do not take on a stream of mortgage payments which will last longer than 15 years, and preferably not longer than 10 years. Spend less, borrow less and enjoy more.

Responsible home buying is not about being able to come up with the monthly payment, but instead it should begin with making a substantial down payment.

More money down means less money borrowed and less mortgage debt owed. And a short duration mortgage loan means a lower interest rate along with more principal paid with each payment.

More equity means more assets owned free of debt offsets.

Less debt, more equity and lower interest rates all translate into good things for the happy home owner and responsible winning buyer.